Collateral Warranty - Why Do You Need One?

Five years ago XYZ Ltd leased a brand new office building after winning a large contract and urgently needing extra space. The developer did not offer collateral warranties and also insisted XYZ Ltd entered into a full repairing and insuring lease. After some half hearted resistance XYZ Ltd accepted this and signed the lease.

Four years later cracks appeared in the building and a structural survey identified a combination of poor design and workmanship as the problem. The landlord served an extensive and costly schedule of dilapidations on XYZ Ltd and, to make matters even worse, XYZ Ltd had to move out of the building during the remedial works causing serious disruption to its business.

XYZ could not sue the architect and contractor responsible for the design and construction of the building as they did not have a collateral warranty.

So what is a collateral warranty and who provides them? A collateral warranty is a document creating a direct contract between the tenant and the contractor or designer. They are usually obtained from the main contractor, architect, structural engineer, mechanical and electrical engineer and quantity surveyor. Further collateral warranties are often obtained from sub-contractors with significant design responsibilities. If properly drafted it gives the tenant the same rights as the developer who employed the contractor and designers, and the benefit of the collateral warranty can also be transferred to future tenants of the building.

A collateral warranty also gives the tenant a licence to use the drawings and reports prepared in connection with the construction of the building. This may be important when it comes to repairing and maintaining the building.

Contractors, designers and their indemnity insurers accept collateral warranties as a necessary evil, but do their best to limit their liability. For example, a collateral warranty signed as a deed runs for 12 years but a document which is simply signed only runs for 6 years. Also, the number of times a collateral warranty can be transferred is usually restricted to twice. Contractors and designers often try and limit their exposure by putting a cap on their maximum liability.

Collateral warranties are not complete protection against defects. Establishing liability for the defect may not be straight forward, particularly where more than one designer or contractor is responsible for it.

If the contractor or designer is no longer trading the collateral warranty is likely to be worthless if its professional indemnity insurance has lapsed. It’s not the insurers at the time the collateral warranty was entered who are liable but instead the insurers at the time of the claim.

If XYZ Ltd, had taken their time and insisted on the developer providing collateral warranties then things would not be looking as bad as they now are.

Published 04/04/2007.